The daft.ie report has published a quarterly series on yields for residential property since 2006. The national average yield has moved between 3% and 3.5% over that period, with some areas of Dublin and Limerick enjoying the highest yields of between 4% and 4.5% in the same period.
Yields are a hugely important indicator in property markets, especially in property markets where the rental segment is significant, as it is in Ireland’s urban centres. Indeed, given the much greater integration of rental and sales segments of the market over the past decade (i.e. you can now rent accommodation of the same standard as accommodation you can buy), yields are one of the most important medium-term indicators of health. Mathematically, of course, yields are essentially just a variant of the house-rent ratio. Rebecca Wilder shows just how far Ireland is an outlier by that measure over on newsneconomics.com – but crucially her chart doesn’t take account of how interest rates have changed. If the expected long-term interest rate has changed from, say, 12.5% to 5%, a movement in price rent ratios of 2.5 might be rational.
So, if we take in to account interest rates, what does Ireland’s property market experience over the past 10 or so years look like? The graph below shows the average yield for Dublin, using daft.ie and CSO rents as well as median interest rates for borrowing, from 1996 on.
Until I can get the CSO data on rents for pre-1997 (not available online), we won’t know what happened before EMU and the euro were factored in. Nonetheless, it is the case that interest rates went from being in the 7-8% range before 1998 to 6% or less from 2000 on. The problem is that yields show that people seemed to believe that the medium-term average cost of borrowing would be in the 3% range, not in the 5% range. The potential elephant in the property market room, therefore, is that the yield realistically will have to settle at somewhere close to 5% – perhaps 5.25% or so – to have anything like a normal property market.
Oversupply on the rental market currently suggests that rents may fall steadily over the coming year. If rents were to fall 5% a quarter until mid-2010, the average Dublin would be €866, compared to a peak of €1,131 in early 2008. Rents would be at levels last seen in 1998. A yield of 5.25% would suggest an average house price in Dublin of €181,000, compared to a peak of €430,000.
Therefore, it seems that the post-Celtic Tiger property bubble, ca.2002-2007, did more than churn out too many properties. It also knocked out of kilter the rent-house price ratio. This creates two levels of correction in house prices. The first is having to deal with overproduction of houses between 2002 and 2008 – by my estimates 12 years supply were built in just 7 nationwide. The second is getting used to medium-term interest rates that won’t be 3% as the market seems to have hoped over the last few years, but perhaps 5-6%. For Dublin yields to adjust to a level of 5.25% in an environment where rents look like falling 33% from their peak, house prices would have to fall almost 60% from the peak.
I guess some might see an upside of having such low interest rates at the moment, in that the market will have a bit longer to adjust. That of couse is a downside for those hoping for a swift return to normality over the coming years.